Securities Lending Today

Lucky number 7?

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If you get a 777 on a slot machine, it will probably make you happy.  If you get a 777 on the Dow, well that's a different story.

Today we are dealing with the aftermath of the botched rescue deal that selfish, self-interested US politicians torpedoed last night.  The Dow's disaster has been replicated across Asia and into Europe this morning.  Interestingly Hong Kong and Shenzhen are the best performing Asian indices.  Interesting because as I mentioned the other day, the Chinese authorities have apparently taken a contrarian approach and believe that margin activity is positive for the markets.  Yesterday the Hong Kong Securities and Futures Commission Chief Executive Martin Wheatley stated that unlike regulators elsewhere he felt HK had an effective short selling regime and that they did not need to make any changes at the moment.  He promised to come down heavily on abusive practices, but that this was not in evidence. Getting lessons in Capitalism from China - what is the world coming to? 

Long Chinese regulations, Short US politicians.  (Are you still allowed to short politicians or has that been banned as well?)

Thanks to the Left Field Blog for discovering in AFR.com that the Australians will consider a quick end to the short selling ban, reversing the accounting terminology First Out, First In (FOFI?)

I've added a couple of video links in the sidebar that are interesting.

The Survey has had a pretty good response so far, but I want to run it for another day.  If you haven't responded yet, please do, it will take less than a minute.

Finally, a good Wall Street Journal Opinion piece by Arturo Bris which makes a very strong case for ending the short selling ban based on his observations of market behaviour last week.

I think i'll go with the Chinese lucky number 8.  No particularly good reason, but its got to be better than 7 at the moment and the Chinese seem to be on a roll today.  The trend is your friend!

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Securities Lending Volume Survey

An article just came out in TradersMagazine.com where Nina Mehta asks about the impact of the short selling restrictions on High Frequency Traders.

Many people have been asking me about what is happening to securities lending volumes.  I have had a number of discussion, but it's all anecdotal at the moment.  I'd rather get your views, so why don't we do another survey!  Please go here and fill in the survey.  Two questions - in which capacity are you responding and how has your business changed in the past week?  There is also a text box for any free format comments you wish to make.

Unscientific?  Sure, but let's see what people have to say.

Design change

This blogging thing is weird and you have to cope with unexpected problems without having a team of techies to rely on.  Some very odd behaviour today has resulted in the design change.  Don't know if its permanent.  Heck - which do you prefer?

The Pendulum Swings

I bought my first flat in the UK at the top of the cycle in the late 1980’s funded on a floating rate mortgage.  That mortgage certainly fluctuated, more than doubling from its original cost at one point. I was able to hold on for a few years and able to turn a small profit.  Of course, by that stage many unfortunate people were losing their homes and I was able to sell a two bedroom second floor flat and buy a six bedroom house for the same money.  My plan was largely flawed – I was counting on cheap funding costs and asset value appreciation when I bought the flat and it just didn’t happen that way.  Fortunately I chose the location well and so was protected.   The only thing I did right was choose a quality asset and I was lucky enough to be able to fund it until it came good, at a time when many others couldn’t afford to do so.  I think we can extrapolate this micro example to many other companies that are in trouble today.  Buying at the top, or competing for market share without taking into account worst-case scenarios, will likely lead to failures.  There are enough examples of this in the professional market today to bear out my personal experience.

Those failures are not only obvious to short sellers, but also mainstream investors.  The disclosure of short positions on UK financials hasn’t revealed really massive positions from surprising sources. Today hedge fund managers are preparing to disclose their US short positions as well, so people – i.e. media – will get a chance to see who is short their stock.  While there is always the potential for shock, I’m not expecting anything.  If long-only investors see short positions they don’t feel are fundamentally sound, then surely that’s a buying opportunity and that’s what makes a market.  For every trade there is both a buyer and seller, and with the recent easing in the US, it is easier for companies to buy back their own shares if they believe they are below a fair value.

As I mentioned in the “Dead Cows” blog of 19 September, changing the rules mid-stream can be dangerous.  That day I heard about someone with losses in their Preferred Stocks trading book.  Today there is a Financial News article on the unintended consequences of the short selling ban including “Lower liquidity in financial stocks, a smaller pool of sub-underwriters and an expected increase in the cost of raising capital” as well as others products including convertibles.

Several institutions have restricted their securities lending programmes and others have said they are reviewing them.  The majority of these funds have been lending for years, and I have to tell you I don’t quite get why they feel the need to change.  Regulators haven’t told anyone to stop lending, although one or two have tried to use moral suasion.

Do these institutions and regulators think that the short sellers have only just realised all this stock was out there for them to borrow and short?  Or is it that politicians have been desperate to find someone to blame and the media have been all too keen to jump on board.  Or is it that some of the investing institutions have realised their own portfolio performance is underwater and are also keen to jump on the bandwagon. 

Perhaps they want to review their counterparty exposure or collateral policies and discuss these issues with their providers and others in the market.  That is to be encouraged.  If that is the case, then that should be the message, and it is not the one that is being put out there.

Hopefully, this is all part of a normal market cycle and that the pendulum has swung heavily and quickly against the short sellers and by implication the stock lenders.  The disclosure requirements may be painful, and indeed may cost some firms as others monitor and trade against them.  However, the best and only chance to fight against the current irrationality is facts and data.

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Here we go again!

Image by Getty Images via Daylife

We have just finished a full week of the restrictions on short selling and guess what.  At the time of writing this, stocks remain under pressure and there is potential for at least one or two banks to disappear this weekend or need assistance in some way.  So the restrictions haven’t really had any impact have they?  That must mean that it is not the short sellers that are driving down the prices of stock. 

The bank that is on the verge of nationalisation (probably complete by the time you read this) is Bradford and Bingley.  The share price has continued to deteriorate despite the ban on short selling the shares.  As pointed out by others, this demise is NOT NEWS.  It is the obvious result of a bank that has the biggest market share of British landlords - the UK buy-to-let mortgage market.  Correct, the same buy-to-let market that has default rates going through the roof.  That’s bad.  And oh yeah, this market share has been built on the basis of funding through open market borrowing.  Only have of their book is funded by depositors.  When bank lending started to dry up last summer, things that must have put further pressure on spreads.  That’s bad too.  And then there was the nickname they earned from their botched up rights issue this summer - “Bungled and Badly”.  As the name suggests - BAD. Clearly no other banks have thought that B&B was worth buying.  Your peers don’t want you - yup, bad again.  So the result is shares that have dropped, with investors selling as there is no sound basis for buying or holding the shares.  Sounds a bit like Northern Rock doesn't it? 

Read this article from the Joe Nocera blog for the NY Times.  This blog is guest authored by Cliff Asness, managing partner of AQR who adds to the argument for short selling heroes.

I think that the media frenzy will move away from blaming the short sellers as the results from restricting short selling have clearly shown little impact.  Maybe in time, we will get back to a more rational discussion and debate.  MAYBE.

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